Cyprus … or Why the ‘No-Demos Problem’ Defines the Policy Response to the Eurozone Crisis

This post originally appeared on EUtopialaw and is cross-posted here with permission.

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Mervyn King’s now almost legendary quip about the global financial crisis—that global banks are ‘international in life, but national in death’—applies with even greater force to the Eurozone crisis.  And the consequences are increasingly devastating for European Monetary Union (EMU), as the unfolding drama in Cyprus well demonstrates.

In each stage of the Eurozone crisis—Cyprus simply being the most recent—we have been reminded that Europe’s banks, while purportedly ‘European’ in life (and allowed to grow, regardless of location, to an apparently ‘European’ scale), are very much national in their agonistic struggles to survive, ultimately dependent on national resources (or, in the case of Cyprus, also their depositors themselves).  When viewed relative to national resources—that is, access to capital to resolve/recapitalize or even just to insure deposits—many Eurozone banks (not just those in Cyprus) are potentially bloated and dangerous monstrosities, posing huge systemic risks to the EMU as currently constituted. Bailouts coming from the likes of the EFSF or ESM—channeled as they are through national governments, subject to strict conditionality—do not change this conclusion.  In fact, by ending up on national balance sheets and thus massively expanding national debts, these ‘bailouts’ only exacerbate the problem.

European leaders stated last June that they wanted to break the ‘the vicious circle between banks and sovereigns’.  Ever since, however, the core countries have done seemingly everything they could to perpetuate the ‘sovereign-bank link’.  Their actions have ensured that the entire cost of the EMU’s flawed design is born by the countries in the periphery, via austerity, the expansion of national debt, and now potentially the destruction of peripheral banking through depositor bail-ins and capital controls. There has, in other words, been no recognition of the fault that all Eurozone countries share in the flawed design of the EMU, or of the concomitant obligation to pool resources to solve the devastating problem of ‘legacy costs’.  Therein—as the innumerable advocates of a genuine European banking union have pointed out—lies the true heart of the Eurozone crisis. Europe will apparently get some kind of single regulatory supervisor for at least part of its banking sector.  But what it really needs, as so many recognize, is a common resolution mechanism and deposit guarantee scheme backed by the full fiscal capacity of the Eurozone as a whole (i.e., unshackled from the limitations of any single member state). 

The situation in the EMU today reflects the perversely ‘partial’ character of banking integration in the Eurozone.  I say ‘partial’ because Eurozone banks have apparently been well ‘Europeanized’ in terms of deposits and lending (very much consistent with the single market aspiration) but apparently not much else that is necessary to make such a single banking market a durable functioning reality. Despite the conveniently exculpatory critiques from the likes of Angela Merkel that the problem was the ‘Cyprus business model’, that model is arguably different only in magnitude but not in kind from what prevails in many other member states. As Gavyn Davies nicely put it in the FT, Cyprus is simply a ‘microcosm of the entire eurozone crisis, if a microcosm on steroids’: ‘an over-leveraged banking system, with insufficient capital and reliance on foreign funding,” all of which “is familiar territory in the Eurozone’.

The Cyprus Bailout, Deposit Guarantees, and the Single Market

Here at europaeus|law, we're monitoring the intense fallout from the announcement by the Eurogroup last night that the Cyprus bailout will be conditioned on an "upfront one-off stability levy" on deposits in Cypriot banks.  The levy -- 9.9% on bank deposits exceeding 100,000 euros and 6.7% on anything below that -- will take place on Tuesday after a bank holiday on Monday.

There will no doubt be much more to be said about this in the coming days and weeks, but we note the general expectation that the levy, as structured, will hit small depositors in Cyprus banks especially hard.  Moreover, we want to point out the potential impact that the bailout conditions will have on the single market, notably harmonized deposit guarantee schemes.  As Open Europe asked on its blog:

"Does this move break EU rules on capital controls and/or deposit guarantees? As noted above, it seems that depositors will be blocked from withdrawing their funds from banks. For other EU depositors this surely amounts to a form of capital control – strictly forbidden under the EU Treaty. Furthermore, as Sharon Bowles MEP has been tweeting, this move makes a mockery of the current EU rules on deposit guarantees below €100,000. The Eurozone may protest that the bank shares given in exchange are of the same value, but this is a very thin argument. Either of these issues could be challenged at the European Court of Justice."

Bowles, a Lib-Dem MEP and chair of the EP's Economic and Monetary Affairs Committee, has now issued a press release entitled "The Cyprus bailout deal is a disaster for EU rules andSingle Market principles".  She writes:

"This grabbing of ordinary depositors' money is billed as a tax, so as to try and circumvent the EU's deposit guarantee laws. It robs smaller investors of the protection they were promised. If this were a bank, they would be in court for mis-selling.

"The lesson here is that the EU's Single Market rules will be flouted when the Eurozone, ECB and IMF says so. At a time when many are greatly concerned that the creation of the 'Banking Union', giving the ECB unprecedented power, will demote the priorities of the Single Market, we see it here in action.

"Deposit guarantees were brought in at a maximum harmonising level so that citizens across the EU would not have incentive to move funds from country to country. That has been blown apart.

"What else will be blown apart when convenient? All the capital requirements we have slaved over, what about the new recovery and resolution rules? What does this mean for confidence in cross-border banking and resolution and preventing the fragmentation of the banking sector?

"When the dust has settled on this deal, which I hope it never does, we will see that the Single Market has been sold down the river for a shoddy price. All the worse as the consequences for Cyprus of the Greek bond haircuts were obvious."

On FT Alphaville, Joseph Cotterill (admitedly very half-heartedly) tried to play devil's advocate on this point, noting:

"It’s not as if Cyprus is going out to people and saying sorry, we can’t honour what you’re owed under the depositor guarantee scheme. The levy is parallel to the government’s obligations there. Securing the official loans on Friday night if anything made the looming risks of holding a deposit in a Cypriot bank fade away. These were the counter-party risk, and also redenomination risk, assuming the alternative to a bailout was Cyprus leaving the euro."

There are, of course, numerous other legal issues to consider, as Cotterill points out, quoting a prescient piece last year by Lee Buchheit, Mitu Gulati and Ignacio Tirado. But for now let's focus on on the issue perhaps most on the minds of a network comprised of academic specialists in European law: the impact of the Eurozone crisis on the single market, the cornerstone of European integration for decades.  We'll try to follow up with more updates on this point as events develop, but we invite network members and other readers to chime in as well.